China Property Trusts Fuel Hong Kong Pipe Dreams

(Bloomberg Opinion) -- After several false starts, China is finally moving to roll out real estate investment trusts. Stock-market listings for income-producing pools of property assets are likely to get a warm reception from yield-chasing mainland investors. The development may also bring significant benefits for Hong Kong-listed REITs and the city’s stock exchange.

There’s currently only one such trust listed in mainland China. Issued by developer China Vanke Co. and Penghua Fund Management Co. in 2015, this collective investment vehicle owns a single office complex in Shenzhen’s Qianhai free-trade zone. While the closed-end fund employs a quasi-REIT structure, it differs in lacking a diverse portfolio or ownership rights for the underlying assets, which in other markets are usually held by trustees on behalf of investors.

This time, Chinese authorities have figured out the right structure, and change is afoot. Officials, fund managers and brokers met this spring to discuss final arrangements for launching REITs that would meet international standards. While details are still to be confirmed, the move clearly makes financial sense. China’s total investable real estate universe was estimated at $5 trillion as of 2015, according to a report by LaSalle Investment Management.

Since Chinese REITs may start to appear in numbers on the stock market, it’s likely that the trading pipes linking the Shanghai and Shenzhen exchanges will serve as the conduit for foreign investors to buy them. This will boost trading volume on the Hong Kong stock exchange and spur increasing demand for Hong Kong-listed property trusts among mainland investors.

There aren’t any REITs currently included in the Stock Connect, a program that started in November 2014 to establish a trading channel between the Hong Kong and mainland exchanges. The connect aimed to overcome the high transaction costs and red tape that had deterred foreign investors in the Shanghai and Shenzhen markets. The program now has 571 stocks in Shanghai, 736 in Shenzhen and 481 in Hong Kong that are eligible for trading. That said, the program is far from comprehensive. 

The main REITs aren’t included is that they aren’t widespread in China. So there’s been no reciprocal urge to include the ones traded in Hong Kong. There are other hurdles. REITs are inherently different from stocks. They are, as the name implies, trusts – collective investment vehicles that distribute income to investors through portfolios filled with income-generating properties such as shopping centers and office buildings. As a result, authorities will require further studies and regulatory preparation before admitting REITs to the connect program. 

Still, as the number of trusts on mainland exchanges increases, the case to include them in the Stock Connect will become stronger.

The question now is less whether REITs will succeed in China than how long the process will take. Once the kinks are worked out, global investors need to focus not only on what happens in the mainland, but in Hong Kong. The city’s listed REITs may be poised for an upturn, too.

(Ronald W. Chan and his firm, Chartwell Capital, do not hold positions in the companies he writes about for Bloomberg Opinion.)

To contact the editor responsible for this story: Matthew Brooker at mbrooker1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ronald W. Chan is the founder and CIO of Chartwell Capital in Hong Kong. He is the author of “The Value Investors” and “Behind the Berkshire Hathaway Curtain.”

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